I’m a tax lawyer based in San Francisco (www.WoodLLP.com), but I handle tax matters everywhere. I enjoy untangling a tax mess from the past, disputing taxes with the government or planning taxes for the future. One of my specialties is advising about lawsuit payments. Whether you’re receiving or paying a legal settlement, you can probably improve your tax position. I write frequently about taxes, from expatriation to sales tax, from selling your company to restitution. I’ve written over 30 tax books, but my best seller is still Taxation of Damage Awards and Settlement Payments. Contact me at wood@WoodLLP.com.

Filing Taxes? Beware Sharp Increase In Audit Rates

Ah, tax day with its inevitable fretting over returns, extensions and payments is almost upon us! It’s hard not to think about your chance of audit when filing your taxes. Yet as a tax lawyer, I must assume every return will be audited. If I believe there’s a 50% chance a deduction is correct, my advice must be based on the merits not on the audit lottery.

The IRS has long been criticized for putting too many resources into auditing taxpayers with comparatively simple issues and relatively few dollars at stake. High income persons not only have more dollars on the table but tend to have tougher and more nuanced tax issues. That can make audits more revenue productive.

The IRS has been expanding audits in the upper income echelons for a few years, but in 2011 made great strides. The extremely wealthy are in a class by themselves when it comes to audits. The most heavily audited group makes more than $10 million. A whopping 30% of this rarefied income group was audited last year, up from 18% the year before.

For those making between $5M and $10M, 21% were audited in 2011, compared with 12% last year. Of taxpayers making between $1M and $5M, 12% were audited last year, up from 6.7% the prior year. Even taxpayers in the $500,000 to $1M range had a sharp uptick in audits: 5.4% were audited last year, an increase of 3.4% the year before. See chart below.

Image via thedaily

In all, audit rates are still comparatively low. If you have a 5% chance of being audited, there’s a 95% chance you’ll skate by. But over a lifetime of paying taxes, sooner or later your number may come up. The IRS says only 1.1% of all individual returns are audited, but upper income taxpayers are being targeted today more than in the past.

Don’t confuse these new statistics with the IRS’s Global High Wealth Industry Group—aka the Rich Squad. Launched in 2009, it is more concerned with assets than income. If you have $10M or more in assets, expect scrutiny. Audits can start with a plain old Form 1040 but can expand into gift transfers, charitable issues and excise taxes. See Avoid IRS Audit Triggers.

The high-net-worth person can expect a holistic approach, including family companies, gifts, and more. The IRS is turning big guns who are trained to ferret out data from large and sophisticated businesses on individuals. That means the IRS will ask questions and want documentation for virtually everything, overwhelming even wealthy taxpayers. See Richie Rich Tax Audits.

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